China is making a new 5-Year Plan — and it'll decide the fate of the global economy

Between October 26 and October 29, the 18th Central Committee of
the Communist Party of China will hold its 5th annual "Plenary
Session," and announce the country's 13th Five-Year Plan.

That might sound like a bunch of Mao-ist
gobbledook to most of us in the West, but if you're interested in
where the global economy is heading next, this is The Big
One.

China will use the plenum to set its GDP
growth rate for the next five years.

And if delegates start talking about any number
lower than 7%, you can expect markets and projections to tank
planet-wide.

You might think this won't affect you because
you're not Chinese. Wrong. China represents 32% of all global GDP
growth, and about 30% of global capital expenditures, according
to Credit Suisse. In other words, If China sneezes, the rest of
us will get pneumonia.

Here is the context: Over the last five years,
China has promised to deliver GDP growth of around 7%. But growth
in China has slowed recently and many economists have begun to
suspect that China's self-reported GDP numbers are basically
lies. Andrew Garthwaite, an analyst at Credit Suisse, last week
said in a note to investors that China's real growth rate may be
as low as 3% — or 400 basis points below where
premierLi Keqiang says it is.

Now, people are used to the idea that China
isn't telling the truth about its real growth. So they discount
the number. But if the next Five-Year Plan were to name a number
lower than 7, then everyone's discounted models would be racked
down one notch as well, to compensate.

And that is a lot of models, at a lot of
companies. The global mining giant Glencore, for instance, is
really banking on continued demand from China for copper, another
material you need if you're building anything:

Citi

The price of copper could collapse, and
Glencore's stock with it, if China says something like,
"Actually, we're not gonna make 7% for the next few years ...
sorry guys!"

Two analyst teams at two investment banks put
out notes last week that said China is the scariest thing on
their radars. Here is Andrew Garthwaite and his team at Credit
Suisse:

China concerns: China was the number one topic
[of concern among clients]. The currency and PMIs were seen as
key barometers. Clients agree that 'real' data (even on the
consumer side) are consistent with just 3-4% GDP growth. China
has never faced a downturn when it has been this large (32% of
global GDP growth and c30% of global capex) and has had such
excess in investment, credit and real estate.

And this is Hak Bin Chua and the team at Merrill
Lynch:

We worry about the next phase: the leverage
channel where the financial difficulties faced by
commodity-related (e.g., Glencore) or leveraged-China companies
could set off a contagion which could hurt the rest of Asia via
bank exposures. Recessions or downturns accompanied by banking
problems are often far deeper and last longer. The debt-linkages
remain a tail-risk but the tail is probably getting
fatter.

To sum all that up in plain
English:

China's economy is
slowing.

The demand for things like
Glencore's copper has collapsed over the last five
years.

Everyone is worried about
banks that have loaned money,
or have credit default swaps, where the value of those bets
is dependent on underlying assets like copper.

While there are still uncertainties on the growth target in the
13th Five-Year Plan, people’s expectations seem to have zeroed in
on two possibilities, 7 percent or 6.5 percent. Currently we
believe that the likelihood of keeping 7% growth target is
slightly higher than cutting it to 6.5%. The two possible targets
will have very different implications on policy outlook. If the
target is set at 7%, we believe the government will have to
maintain its loose policy stance and do more easing. As a result,
the leverage of the economy will continue to rise. On the other
hand, if the growth target is set at 6.5%, it means the
government will tolerate slower growth to allow more space for
structural adjustments. In this case, we expect there will be
less stimulus efforts by the government.

The problem with that is, we won't know how much
trouble we're in until it's too late.